Accuray: From Innovation to Profitability

Biotech and innovative medical device firms are usually assessed based on the potential of their product or pipeline, rather than on traditional metrics. Chelsea Therapeutics (CHTP), a company I wrote about in these pages a couple of weeks ago is a case in point.

Speculation that Northera, their drug to treat orthostatic hypotension, will gain Food and Drug Administration approval is largely responsible for the performance of the stock (+ approx 20%) since that article, and as "decision day" approaches, speculation is likely to continue.

Sometimes, however, the approval and acceptance of a drug, technique or device is only the first hurdle. Take Accuray (ARAY), for example. They are a device maker whose main product, the CyberKnife, is a robotic radio-surgery system. Non-invasive surgery for cancer patients has been adopted and recommended for some time. The FDA granted approval for the CyberKnife to be used for treating cancer in any location in the body back in August of 2001. Since the IPO of ARAY in February of 2007, however, the stock has hardly been a roaring success.

Figure 1: ARAY since IPO (Courtesy of VectorVest)

The problem is that, no matter how good the product, biotech firms must eventually become profitable, and the transition from research to sales is, for many, difficult. CyberKnife has all of the needed approvals and is increasingly being accepted in the medical community, yet ARAY has failed to make a profit and consistently disappointed with earnings.

The belief that 2014 will be a good year for Accuray, therefore, is not based on any revolutionary new product or application for an existing one. Rather, it is based on a good, old-fashioned look at the business.

While earnings (or rather the lack of them) have disappointed in 2013, the company has been able to significantly reduce losses this year compared to last. That improvement has led to significant gains in the stock in the last three quarters of 2013.

Figure 2: One Year ARAY (Courtesy of VectorVest)

The trends toward increased sales and lower costs do, however, seem to be continuing. ARAY fell short of their budget for operating costs last quarter, but still increased sales, and when a company gains on both sides of the costs/revenues equation, rapid progress can be made. The medical device industry typically displays a price-to -sales ratio (P/S) around 5, so even given the gains in the stock since May ARAY doesn't look overvalued at a market cap of $653 million and annual sales of $309 million, a P/S of 2.11.

Inventing and creating new medical technology is not easy, but the skills required are not the same as those needed to run a profitable company. For this reason even brilliant ideas often take time to translate into profit, but once the trajectory is in place gains can be exponential. That P/S of 2.11 also makes it possible that ARAY could be targeted for takeover by a bigger firm and any speculation in that direction would be a positive.

Of course there are risks. Improved technology from competitors could result in sales growth slowing, for example. This is a risky, volatile sector, so investments in any individual companies should be kept small. I do believe that ARAY can continue their turnaround to profitability in 2014 and that the stock will likely reflect that.

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